Download - What is Software Worth ?
Oct 2004 Gio: Worth 1
What is Software Worth ?
Gio WiederholdStanford University and MITRE Corp.
October 2004, revised Dec.2004
www-db.stanford.edu/people/gio.html
Oct 2004 Gio: Worth 2
Current State
• Software producers traditionally care about– Cost of writing high-quality code– Time to complete products– Function & capabilities
• When the value is a concern– Business people– Economists – Lawyers– Promoters
life
create
useassess its value:inconsistentlysubjectivelynaivelybadly
Oct 2004 Gio: Worth 3
Why a Concern
• Making decisions about creative tradeoffs– Elegance versus functionality– Rapid generation versus maintainability– Careful specification versus flexibility
• Dealing with customersDijkstra model: for self-satisfactionEngineering model: formal process driven Startup model: see if it sticks to the wall
• Gain respect: know what you are doing
Oct 2004 Gio: Worth 4
Why me
• Much software is being exported as part of offshoring (offshore outsourcing)
• It is typically property – i.e., protected
• If it is not valued correctly – i.e., too low1. Loss of income to the creators in the USA
2. And loss of taxes to the US treasury
3. Excessive profits kept external to the USA
4. Increased motivation for external investment
Oct 2004 Gio: Worth 5
Intangibles
• Product of knowledge by• Cost of original >> cost of copies
1. Books authors
2. Software programmers
3. Inventions engineers
4. Trademarks advertisers
5. Knowhow managers
6. Customer Loyalty long-term quality
Ever
Even
Less
Tangible
Oct 2004 Gio: Worth 6
Valuation of intangibles
• Principle The sum of all future income discounted to today (NPV)
• Example Value of a well-known company (SAP)– Largely intangible – like many modern enterprises
1. Bookvalue – sum of all tangible assets [10K] €6.3B 20% 2. Market value = share price × no. of shares €31.5B 100%3. Difference: value of SAP’s Intangibles €25.2B
80%
– How much of it is software ?• No numbers given, although it’s the majority of its property.
We have just the stockholders’ guess.
Oct 2004 Gio: Worth 7
Software is slithery !
Continuously updated
1. Corrective maintenance bugfixing reduces for good SW
2. Adaptive maintenance externally mandated
3. Perfective maintenancesatisfy customers' growing
expectations
Life time
Ratios differ in various settings
100%
80%
60%
40%
20%
Oct 2004 Gio: Worth 8
IP sources for
• Corrective maintenance– Feedback through error reporting mechanisms
• Inadequate protection• Taking care of missed cases • Complete inadequate tables and dimensions
• Adaptive maintenance– Staff to monitor externally imposed changes
• Compliance with new standards• Technological advances
• Perfective maintenance– Feedback through sales & marketing staff
• Minor features that cannot be charged for
Oct 2004 Gio: Worth 9
Effect: SW Growth
R and W
Rules: Sn+1 = 2 to 1.5 × Sn per year [HennessyP:90]
Vn+1 ≤ 1.30% × Vn [Bernstein:03]
Vn+1 = Vn + V1 [Roux:97]
at 1.5 year / version
Deletion of prior code = 5% per year [W:04]
Oct 2004 Gio: Worth 10
Observations
• Software cannot grow exponentiallyno Moore's Law here
Because1. Cost of maintaining software grows exponentially
with size [Brooks:95]
2. Can't afford to hire staff at (exponential rate) 2
3. Cannot have large fraction of changes in a version
4. Cannot impose version changes on users < 1 / year
5. Deleting code is risky and of little benefit
except in game / embedded code
Oct 2004 Gio: Worth 11
Price remember IP =f(income)
• Price stays ≈ fixed over timelike hardware Moore's Law
Because1. Customers expect to pay same for same functionality
2. Keep new competitors out
3. Enterprise contracts are set at 15% of base price
4. Shrink-wrapped versions can be skipped
• Effect
The income per unit of code reduces by 1 / size
Oct 2004 Gio: Worth 12
Growth diminishes IP
at 1.5 year / version
Oct 2004 Gio: Worth 13
Total income
Total income = price × volume (year of life)
• Hence must estimate volume, lifetime
Best predictors are Previous comparables Erlang curve fitting (m=6 to 20, 12 is typical)
and apply common sense limit = Penetration estimate total possible sales F ×
#customers above F= 50% monopolistic aberration P
Oct 2004 Gio: Worth 14
Sales curves
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,000
Erlang m = 12
Erlang m = 6
| | end of time horizon| 9 years|
^ 50,000 w hen| Erlang m ~ infinite
For 50 000 units over 9 years
Oct 2004 Gio: Worth 15
Software users
Companies that
1. develop & sell software * • Basis of IP: income from sales
2. purchase & license software for internal use• Do not generate IP with software
3. develop software internally for their own use• Basis of IP: relative SW expense × all income
(Pareto rule)
4. combinations
Oct 2004 Gio: Worth 16
*Fraction of income for SW
Income in a software company is used for
• Cost of capital typical– Dividends and interest ≈ 10%
• Routine operations -- not requiring IP – Distribution, administration, management ≈ 40%
• IP Generating Expenses (IGEs)– Research and development, i.e., SW ≈ 25%– Advertising and marketing ≈ 25%
These numbers are available in annual reports or SEC 10-Ks
Oct 2004 Gio: Worth 17
Discounting to NPV
Standard business procedure• Net present Value (NPV) of
revenue 1 year later = R×(1 – discount %)
Standard values are available for many businesses
based on risk (β) of business, typical 15%
Discounting strongly reduces effect of the far future
NPV of $1.- in 9 years at 15% is only $0.28
Also means that bad long-term assumptions have less effect
Oct 2004 Gio: Worth 18
Combining it allfactor today y1 y2 y3 y4 y5 y6 y7 y8 y9
Version 1.0 2.0 3.0 4.0 5.0 6.0 7.0
unit price $500 500 500 500 500 500 500 500 500 500
Rel.size 1.00 1.67 2.33 3.00 3.67 4.33 5.00 5.67 6.33 7.00
New grth 0.00 0.67 1.33 2.00 2.67 3.33 4.00 4.67 5.33 6.00
replaced 0.00 0.05 0.10 0.15 0.20 0.25 0.30 0.35 0.40 0.45
old left 1.00 0.95 0.90 0.85 0.80 0.75 0.70 0.65 0.60 0.55
Fraction 100% 57% 39% 28% 22% 17% 14% 11% 9% 8%
Annual # 0 1911 7569 11306 11395 8644 2646 1370 1241 503
Income K $0K 956 3785 5652 5698 4322 2646 1370 621 252
SW IP 25% 0 239 946 1413 1424 1081 661 343 155 63
Due old 0 136 365 400 311 187 93 39 14 5
Disct 15% 1.00 0.87 0.76 0.66 0.57 0.50 0.43 0.38 0.33 0.28
Contribute 0 118 276 263 177 93 40 15 5 1
Total $ 989 K ≈ $ 1 million
Oct 2004 Gio: Worth 19
Result of Example
• Selling 50 000 SW units at $500 ≈ $ 1M
not $ 25M
Once it’s in a spreadsheet, the effect of the many assumptions made can be checked.
When assumptions later prove unwarranted then management can make corrections.
To be wise, spend less than ≈ $500 000 to develop the software product.
Oct 2004 Gio: Worth 20
Alternate business model
Consider maintenance and its income
long-term "Service model"
• More assumptions – now include cost1. Original cost $494 000 (used to estimate 2.)
2. Maintenance cost 20%/year of original cost
3. Maintenance fee 15%/year of original price
4. Lag = Δ (t cost , t income) = 1.5 years 5. Stop maintenance when cost > total income
Oct 2004 Gio: Worth 21
Effect of service modelSW cost $494K today y1 y2 y3 y4 y5 y6 y7 y8 y9
Version 1.0 2.0 3.0 4.0 5.0 6.0 7.0
Maint.cost 0 99 165 231 297 363 429 495 560 626
disc. for lag 0 122 203 285 366 447 529 610 691 772
Income - cost 0 834 3581 5369 5332 3875 2117 761 -70 -520
Aggreg.sold 0 860 4558 9755 14477 17352 18262 17806 16645 15233
Maint. Inc. 0 0 129 684 1463 2172 2603 2739 2671 2497
Sum 0 834 3710 6052 6795 6047 4720 3500 1977
15% disc/year 0 725 2806 3980 3885 3006 2040 1316 562
Total $ 19170 K ≈ $ 2 million after paying $1 780K (disc.) for maintenance
Good time to quit if no maintenance income
20% if designed for maintenance
typical
Cost of actual maintenance = 3260/(494+3260) = 87% of total
Generates income10 more years
2601
850
Oct 2004 Gio: Worth 22
Long Term
Red
uce
mai
nten
ance
Oct 2004 Gio: Worth 23
Service model
Analysis shows profitability in service model
• To achieve such a beneficial model1. Management must value maintenance
2. Marketing and sales must provide feedback
3. Education and training must recognize the value of maintenance and maintainability
– Often ignored today1. Academics don't teach it (3/850 pages [Pressman:01])
2. Companies give maintenance tasks to novices Experienced programmers should maintain their work
«
Oct 2004 Gio: Worth 24
Knowing what software is worth
• Allows rational design decisions, as• Limiting development efforts• Programming investment for maintenance
• Allows rational business decisions, as• Choice of business model• Where and when to invest• How to assign programming talent
• Improve focus of education in software• Consider quality, not just quantity in assignments• Effectiveness of curriculum